Wednesday, July 15, 2015

The True Nature of the Greek Crisis – How it will All End; Germany is Closing in on Their Own Default

If you recall my thesis in 2011, I sketched Europe as a constitutional
crisis and not related to finance,
though most then saw Europe as a financial problem contained in units of
the separate EZ states. They still do –
everyone still does.

But I was right , and as usual for my forecasts, since they are usually dependent on a political read
rather than a micro-economic read, I have had better foresight. But I also
have a lack of timing as I am not very involved with the noise of the markets. By noise I mean the quarter to quarter
swings. I have found the important
market moves occur on a seven to ten year cycle based on a political
cycle (two terms for POTUS time usually).

So with the same qualified foresight I showed in 2011, I wish to present my current view on Europe.

I am confident I have “nailed” the current situation.

Basically, I hold the same view as I had in 2010. Europe is still a constitutional crisis and
has little if nothing to do with Greek debt.

Greece is immediately very important, but as most have
quickly deduced it is “only” a problem as the entire Greek debt is a bit under 3% of the Euro area. So Greece is only a tactical situation now
for most, with focus on the terms of the deal.
Greece ha d no choice but to surrender as Germany was ready to plunge
the country into some Lutheran hell of original sin, backed by the other
moralist Finland. This not good for the
Greeks, they will be beaten into submission and become a debt colony of
Germany. But is quickly being priced as
a small factor for US and world markets in general. At the time of this writing the SP500 was
traded up 70 points to 2107, a large move, since Weds lows last week.

The more useful long term analysis would be at first curiosity
as to why Germany was so adamant and so belligerent for what is really a small problem. How they deployed the extra-EU Treaties institution to do the job – the Eurogroup – so as to avoid conflict with and control France and Italy. Why did Germany find itself at odds with
France. Why the debate was contained for
5 months in the Eurogroup with what
Yanis Varoufakis called a plot.
- so that in the end Greece faced a pre-planned outcome imposed upon them. The above hyper link to Varoufakis interview is a must read. When reading Varoufakis it should be noted
that he has the historical read of a Marxist – ie brilliant. [ It is always best
to use a Marxist to tell you where you are and how you got there, but then drop
him and replace him with a Kissinger or a Fukuyama or a Keegan for forward for
policy planning then a Nixon for implementation.]

Via answering the above questions the true nature of the
European crisis becomes clear.

Germany is facing, and
will experience, if nothing is done,
default.

Germany has built its own demise in typical Germanic
fashion, only it was via trade locked into the de facto gold standard of the Euro
(for all those in the EZ) , and not armies that have built the " Fourth Reich" rise and will assure the fall of Germany in the end.

Trade economics are relatively straight forward, one of the
first economics defined as far back as Hobson and Ricardo. Trade economics uses a ledger, a Pacioli double entry accounting
approach. In international trade if one nation sells
something to another, the seller needs to settle “money on the
barrel”. If the two trading counterparty
nations are in balance, with no chronic competitive imbalance in the terms of
trade, then the trade processing ends, and after short term trade financing is
paid down, both countries current account is unchanged. All common sense and easily described by
Ricardo.

But if one country enters into trade with another that has chronic competitive advantages in terms
of trade, usually because of large
constant better factors of production like
labor costs and more often than not a “rigged” currency, there are no comparative advantages. The
country with the chronic competitive advantage not only sets the price, sells
the good with one-way trading, but also finances the trade. If the rigged currency levels can be maintained, as well as the advantages in a
lower cost of labor, with large constant
savings rate, it is inevitable that the
exporting country not only exports the trade goods, but will inevitably finance the trade flow via debt from their larger
savings rate, and has ever increasing
positive current account as well as a chronic trade surplus for the exporter
and chronic trade deficit for the importer as well as mounting current account
deficit financed by ever accumulating debt balance to the exporter. Hobson described this centuries ago and
provided its name: “mercantilism”.

The mercantalist colonial empire requires hard power, or
some means of coercion and enforcement to keep the importer in thrall. Or the
debt simply defaults sooner or later.

If the mercantalist does not have the ability to enforce or coerce the
importer into line, then what is a benefit and empowerment turns into a cancer and
will force an overturn of the mercantilist in a sudden cusp movement – a very
bad week for the exporter.

A good rule of thumb is that without enforcement and ability
to maintain a long term colonialization
of the importer, the accumulated trade surplus in the accumulated current
account will be lost or be devalued an amount approximately equal to whatever was the trade advantage. Then as the importer balks, and refuses servicing and repayment of debt, or simply cannot do so as the only rebalancing
available is the raising of competiveness via mass unemployment, weakens the economy such that the debt cannot be serviced . Or the importer finds better terms away. Giving the precedent that this cycle almost
always occurs, it would be better for the exporter to look forward and manage the debtor, always
keeping the importer in good health, and certainly never let the importer get
to the point where there is nothing to lose and such that they revolt and default. This is accomplished by
equalization payments, or transfer payments or mass rebalancing like the Marshall
Plan of which the largest recipient was Germany itself.

It is not clear if Germany knows they are in this situation with
Greece, they may indeed believe in the clap-trap of Schaeuble. What made Germany’s mercantilist status is
not readily apparent and by being so may even have fooled Germany. That Germany believes Greece arrived at their
current status by choice. Even the great Paul Krugman who one his Nobel Prize in trade economics, misses that the Greek debt crisis is a classic mercantalist trade imbalance problem.

Germany, Krugman and others may not even be aware of the German policy and factors for intra-EZ trade for the last
15 years, as it was cloaked under the
Euro.

German labor reforms
so as to reunite with East Germany, the
cheapening of the DM value by absorbing the Ost Mark at clearly off the market rates for conversion into DM, and
then the entry into the Euro at a very cheap 2 DM per Euro conversion – all these
factors set up German to pillage almost all their EZ partners trade account.

Germany insisted on no transfer or equalization payments,
and had Karlsruhe enshrine that into the German Constitution. These German terms of trade, and the inability
of any EZ trade deficit partner to
rebalance to Germany but for unemployment, and then Germany – up until 2010 –
is the cause of the crisis. In the USA
if one state has such adverse pressure,
folks pack up the Budget one-way rental truck and move to the other area in the
USA which is doing better, as well as about 20% of the USA budget going to
equalization and transfer payments. In
Europe there is no mass internal migration and there is now no currency, and until
2010 one could add to the debt from Germany to finance the next years trade
imbalance, so massive imbalances have built with Germany since the Euro was
launched and especially since Greece joined the Euro. The impact on the comparative GDP per capita:

And the rampage and damage that Germany is imposing on the
EZ in comparative unemployment rate:

Given that the only way rebalance is to force unemployment, this ends in a perverse cycle as the country gets weaker and unlikely to repay the debt owed.

The level of German trade surplus growth is massive, and
until recently most of that on exports to fellow EZ members. The Germans, by insisting that there are no transfer
or equalization payments, and the confederate nature of the Deutsche Bundesbanke
and to a lesser degree the Bank of
France and the Bank of England, have the internal payment system of Europe to “firewall”
the credit of each of the EZ country’s central bank . As debits and payments are made in the
interbank system, they move to the member country’s central bank and then to
the ECB balance sheet for the credit or debit of the respective country’s
central bank account. The US has a similar system between the regional Federal
Reserve Bank, but the accounts don’t mount as imbalances develop between the
region s, but are cleared each day. In
the EZ system they are not cleared but accumulate. The system is called TARGET2. By monitoring the TARGET2 accumulated
balances at the ECB for each EZ country, an explicit and dynamic picture of the
massive intra-EZ trade imbalances are obvious.

The changes in TARGET2 balances over the years compared to
the change in the current account balances, showing the TARGET2 accumulation
and change is from trade. Germany is the
obvious standout and the accumulated surplus is more or less offset by the
changes in the other member EZ deficits:

The levels of the TARGET2 accounts then is a quick robust
way to track they accumulated debt financing for the trade, as all deficit
trade balance countries must finance by borrowing.

The deficit levels, or accumulated payments owed to Germany
and to a lesser degree Luxembourg (tax shelters for Dutch, German and French
companies for the most part) , when considered as an accurate measurement of
the growing trade balance in the EZ becomes telling. First, Greece is a very small part of this “debt”,
so why the vigorous hammering by Germany and the attempt to remove Greece from
the Euro. It is because Greece isn’t the
problem Germany faces. The real problem
is if all the trade deficit financing becomes one problem – if Italy is
packaged in with Spain. But especially
Spain, as Spain and Italy have not accepted the first bailout as Greece did in
2012, and their debt balances are not with a sovereign Germany alongside IMF
financing, but are still with German financial institutions either directly or
through Spanish and Italian banks. Then
if the unemployment adjustments Germany has imposed upon Spain and to a lesser degree
Italy are added with the now radicalized Greek unemployment a mass of people
appear on the scene that cannot be segmented into individual countries and
overpowered as Germany is doing now. So
Germany is smashing Greece now so as to attempt to prevent that aggregation of
trade debt financing.

All of this could have been avoided if the Jean Monnet plan
for the evolution towards a “United States of Europe” had occurred, instead of
being interrupted post-Kohl. It is
cloudy as to why, but it seems all roads lead to Schroeder and the
reunification of Germany has swung focus of Germany away from the EU and towards
East Germany, but for the annoying Poles.
Germany is creeping towards association with Russia, whatever the
reason.

When I presented this to DC folks in 2011, was the only one
of my group who saw that the crisis from 2010 onwards was solely
constitutional. All of my group dismissed
my thoughts and went onwards into credit, flows, debt and financing. What surprised me at the time, and I did not
understand the importance, was the staff we presented to all agreed with
my views with an almost casual “off course”, all saw it as a political and constitutional
problem. Then they asked our group our
views on when unemployment adjustment would cause civil strife and
violence. All of the NYers were
surprised at the question and of course had no expertise in answering, so we
dropped that question and drove on. I
know realize that was the main point, that we were there not so much to present
new information, but to confirm existing views. That the unsaid view of the USA was to not
encourage or insist on a constitutional remedy to Europe, but to monitor where
the boundary was for mas civil unrest and only step in at that point. That is suited the USA to keep Europe a weak
confederacy under a short term grasping Germany. But, since I had not realized the above until
recently, I can assume that the audience was not watching the Hobson-Ricardo
nature if the building trade deficit financing but were accepting the
moralistic character view of the Greeks making these choices and self imposing
their own problem, along with the rest of the periphery.

But the ability to ride that edge and manage Europe towards
a somewhat chaotic force muddling through are over, unless the USA desires the
default of not Greece, but of Germany and possibly France as well. NATO stuff.

It is useful to very briefly reconsider the Ricardo-Hobson
nature of the current crisis. It is not
due to specific national traits to work and savings of tax scoff law, it is the
Pacioli immutable reality that in a closed system like that the EZ became, without
any adjustments of that imbalance available, the country with high savings ,low
cost of labor and high productivity will “invest” in low saving if not deficit
countries. If the cost of the trade
goods continues to be inefficient, the trade balances will result with the high
saving exporter ever increasing the debt
financing. They will keep doing this
until the unemployment rate, in a democracy, results in an economy that can
never repay the debt and will refuse to service it. The adjustment via unemployment is insufficient
to rebalance so the debt is violently repriced to finish the rebalancing
required via default.

Looking at the TARGET2
balances, and considering past sovereign default, 60% of the TARGET2
level will be how much Germany will face in default – about 400 billion. On a per GDP level, this is about double what
the USA experienced in the 2008 mortgage default solvency crisis.

Germany will be ruined if nothing is done.

Greece is not the problem.
The problem will be and is now Germany.

What can be done also provides prescience.

When a sovereign goes into default they either become
excluded from the globalized financial system or they have a restructuring from
the IMF or the US hegemon. The amount of
400 billion for only Germany alongside with the equal amount required for the rest of the EZ (remember the
books will balance) is beyond the IMF. And
this will happen quickly, especially if
Germany keeps fighting this outcome. And
the USA will not provide a bond swap for that amount either, as the 700 billion
ARRA 09 funding is still being dealt with along with the cost of security as
ISIL and other problems flair. When
this happens Putin will likely take full advantage of the situation and will
encourage many areas “hot spots” as well as continue with their own goals in
the Ukraine and well as Latvia. Russia
will sue this situation to come and “aid” Germany, as well as Greece. It would challenge the continuation of NATO.

What Germany will do, if this unfolds, will seek close
cooperation of all the EZ and build the entity which they could swap their debt
with and remedy the crisis. The only
entity to do that would be a “United States of Europe” where a Eurobond is
swapped for all the defaulting sovereign debt.
That financing and bond issuance would require a federal financial
structure from taxation to setting policy to paying all commonwealth enterprise. As Hamilton did with the US retirement of the
colonies debt with newly issued US Treasurys in 1789, it will launch the United
States apparatus. Unless all of the EZ
wished to grant a dictatorial authority
to Germany to run this new country and manage debt and taxation, all the usual
federal democratic apparatus will appear.
This would be easy to make as all of the EZ would be facing the problems
Greece is facing now, and quickly the corporatist German hegemony partnership
can be swapped into a federal structure.
The ECJ would be activated, as would the population defined European parliament. The Euro Commission becomes the departmental bureaucracy
which would be under an executive that is directly elected that replaces the
Euro Council. To avoid the problems of a
confederacy rather than a federation, the Euro Council would either convert to
an upper chamber based upon state, and the first ministers return home as
governors.

This is what will happen and is the only way I can see
Europe, and especially Germany being ruined.
The question as to whether or not the occupation of Europe by the USA
ends or begins a wind down, but NATO would continue as Germany is turned away
from Russia and back to being one amongst equals in Europe, and a European
common force quickly becomes a full equal to the USA. Which is the end results which I think
motivated the Agency forward looking planners wished to forestall.

I am constantly increasing the regard I have for Jean Monnet
as the above is perhaps the only way the United States of Europe is created. I will go further, I think this will create
and finish the Jean Monnet plan, reviving it from the ashes of the Schroeder
and German re-unification destruction of
the Monnet plan. I think it is now time
the USA swing back to supporting and encouraging the creation of the United
States of Europe. Once this is achieved
all the debt crisis in Europe will disappear as quickly as the debt crisis in
the newly created United States of America with Hamilton’s “Assumption of the
Debt” in 1789.

Then over a suitable time the USA must withdraw from Europe,
allow a European ‘Monroe Doctrine” develop, and accept from time to time a United States
of Europe will have serious differences with the United States. But that outcome, even with the risk of a
bipolar world as the United States of Europe would be every bit the equal in
power to the USA, would be a more secure world for the United States in the
long run, stop Putin’s vain-glorious nostalgia, and balance the load to contain
China. In the long wrong a united
federal republic in Europe would lead to a secure and stable world for
democracy and would be well down to the road of the “end of history”. Fukuyama was right.

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About Me

Many years of experience in being a market maker, a trader, a salesguy or portfolio manager in almost all asset classes known. Have had a high teens average career return and yet can say that I have lost more money in more asset classes than anyone I know.
My biggest curse is that not even wishing to become involved: "I see dead people.", as the kid said in the movie. I can smell a trade in the drawer or financial fraud or PL blowup miles away. Should have been with the FBI if wanted to max social utility.
Autodidact in all things math, formal education in history.